A Surprising Way to Play a Europe Rally

By: Frank Holmes | Tue, Aug 13, 2013
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Europe back in the limelight

U.S. Global's Portfolio Manager Tim Steinle is usually soft-spoken and mild mannered, so our ears perked up when he recently belted out "Europe is Rocking!"

After a lengthy period of stagnant growth and lackluster results, the gradual crescendo of improving economic data that's been coming out of Europe lately certainly commands attention.

As our resident expert of the European economy, Tim has been listing several economic indicators that were turning positive during the investment team's morning meetings. While our entire team keeps track of the economic data and political policies of all the developed G-7 and emerging E-7 countries in the world, Tim keeps his finger on the pulse of European countries at all times in his hunt for outsized opportunities for the Emerging Europe Fund (EUROX).

I previously shared how economic releases have been beating expectations, as shown in the eurozone's spiking Citigroup Economic Surprise Index. GDP is recovering too, with expectations that the year-over-year growth rate will significantly improve over the next year and a half.

Positive surprises and improving economic growth aren't the only indications that the region's economy is becoming healthier. Manufacturing appears to be on the mend. The latest reading of the purchasing manager's index (PMI) was at a two-year high and topped the 50-mark. This indication of expansion hasn't happened since July 2011. And, the PMI in Europe expanded at a faster pace than estimated.

Economic confidence in the region has also been rising. In July, it reached a 15-month high. Generally, when sentiment turns positive, businesses invest more and consumers spend more. We believe this improving confidence will potentially spur positive third-quarter economic growth and help the eurozone to exit its recession.

European Consumer Confidence Chart

Fiscal Drag Moving Out Of Europe

The area's fiscal situation isn't in dire straights as it has been. According to BCA Research, structural deficits peaked four years ago. As a result, during the 2009 to 2012 period, the biggest fiscal drags as a percent of potential GDP were concentrated in Europe, namely in Greece, Portugal, Spain and Ireland, four of the five members of the group formerly known as the PIIGS. Fiscal drag happens when a government's net fiscal position doesn't cover the desired net savings of the private economy.

Looking ahead at the 2012 to 2015 period, the largest fiscal drags are expected to be in other areas of the world. Based on data from the European Central Bank, "the government credit impulse is improving, which should help to lift the euro area economy out of its 'endless recession,'" says BCA.

It's no wonder Tim is cheering Europe on, as these economic data points have important implications for global investors.

Consider the area's PMI, which Morgan Stanley Research found to be a six-month leading indicator of earnings-per-share (EPS). While the EPS for European stocks has remained relatively flat over recent months, it's expected to follow PMI and move up.

PMI Leading Indicator for European Earnings Per Share

Here's another reason to look at the area: Europe has low valuations compared to the rest of the world. Take a look at the normalized price-to-earnings (P/E) ratio, which is trading at "close to a record valuation low," according to Morgan Stanley Research. Compared to U.S. stocks and world equities, European stocks are trading at a significant discount.

Europe is trading Close to Record Low Based on Normalized Price-to-Earnings

So as countries including Germany, France and Italy recover, we have solid reasons to believe their eastern counterparts will enjoy a boost as well.

Take the CE3, which are the Czech Republic, Hungary and Poland. These countries are integral to the supply chain in Europe and dependent on domestic demand as well as its export growth.

We aren't the only ones pounding the table for emerging European countries. Credit Suisse came out with a report recently with a bold headline, "Going Overweight Europe = Bullish CE3." The report makes a case for the Czech Republic, Hungary and Poland as the countries have "cheap markets, cheap currencies, which are commodity importers and are not overheating," says Credit Suisse.

The firm cites numerous positive data, including the CE3's lead indicators moving together with Germany, an improving outlook for employment, recovering real retail sales, wage growth, and regional credit growth.

Stay tuned for Europe's much-anticipated return to the limelight. But before Europe plays before a sold-out crowd, you might want to get your portfolio a front row seat.

 


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Please consider carefully a fund's investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund's returns and share price may be more volatile than those of a less concentrated portfolio. The Emerging Europe Fund invests more than 25% of its investments in companies principally engaged in the oil & gas or banking industries. The risk of concentrating investments in this group of industries will make the fund more susceptible to risk in these industries than funds which do not concentrate their investments in an industry and may make the fund's performance more volatile.

The Citi Economic Surprise Index is a measure that tries to capture how well the data is coming in relative to economic expectations. The Purchasing Manager's Index is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The MSCI Europe Index is a free float-adjusted market capitalization index that is designed to measure developed market equity performance in Europe. The MSCI USA Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in the U.S. The MSCI World Index is a capitalization weighted index that monitors the performance of stocks from around the world.

 


 

Frank Holmes

Author: Frank Holmes

Frank E. Holmes
Chief Executive Officer
Chief Investment Officer
U.S. Global Investors

Frank Holmes

Frank Holmes is CEO and chief investment officer of U.S. Global Investors, Inc., which manages a diversified family of mutual funds and hedge funds specializing in natural resources, emerging markets and infrastructure.

The company's funds have earned more than two dozen Lipper Fund Awards and certificates since 2000. The Global Resources Fund (PSPFX) was Lipper's top-performing global natural resources fund in 2010. In 2009, the World Precious Minerals Fund (UNWPX) was Lipper's top-performing gold fund, the second time in four years for that achievement. In addition, both funds received 2007 and 2008 Lipper Fund Awards as the best overall funds in their respective categories.

Mr. Holmes was 2006 mining fund manager of the year for Mining Journal, a leading publication for the global resources industry, and he is co-author of "The Goldwatcher: Demystifying Gold Investing."

He is also an advisor to the International Crisis Group, which works to resolve global conflict, and the William J. Clinton Foundation on sustainable development in nations with resource-based economies.

Mr. Holmes is a much-sought-after conference speaker and a regular commentator on financial television. He has been profiled by Fortune, Barron's, The Financial Times and other publications.


Please consider carefully a fund's investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

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